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Baby Boomers' Parents Would Envy Their Retirements

Your parents will envy you.

Helaine Olen does a lot of good exposing the dark side of the finance industry in her book Pound Foolish, but I can't get on board with this statement she made in a recent article: "For the first time in living memory, it seems likely that living standards for those over the age of 65 will begin to decline as compared to those who came before them."

Olen describes how most Americans don't have nearly enough money in their 401(k)s to retire. That much is true. But assuming this means retirees will be worse off than previous generations is one leap too far.

First, the IRA wasn't created until 1974, and the 401(k) didn't come about until 1978. If we're making comparisons to the past, forget about today's 401(k) balances being inadequate. A generation ago, they didn't even exist.

Now, we often hear that most workers in previous generations were covered by a pension. But that just isn't the case. According to the Employee Benefit Research Institute, pensions (both public and private) peaked in the early 1990s, when fewer than 4 in 10 Americans over age 65 were covered. Only a quarter of older Americans were covered in 1965. Today, it's around 34%. Pension income made up 20% of all income for Americans over age 65 in 2010. That's actually higher than the 15% recorded in 1975, according to the institute.

The real issue here is Social Security, since it's long been the backbone of most Americans' retirement and will continue to be for decades.

Listen to politicians, cable news hosts, and alarmist journalists talk about Social Security's future, and you get a universal message: The program is underfunded, it's going bankrupt, and cuts are inevitable.

There are simple ways to make Social Security sustainable, and in fact, the program has a promising history of implementing fixes when its solvency is in jeopardy.

But let's assume politicians sit on their hands, and nothing is done to fix Social Security. What happens to retirees?

Social Security is projected to hit a point around 2033 where it can only rely on payroll tax revenue to fund benefits. After that, it will be able to pay retirees about 75% of currently promised benefits until 2087.

A 25% benefit cut would be a political disaster, but it almost certainly wouldn't mean retirees would be worse off than their parents.

Consider the numbers we're talking about, here.

Initial Social Security benefits rise over time with a calculation tied to wage growth, not just inflation. That's allowed average real (inflation-adjusted) monthly benefits to double over the last half-century:

If real benefits grow 1% annually (the trend rate over the last decade) between now and 2033, average inflation-adjusted monthly Social Security payout will be nearly $1,600 a month. At that level, a 25% cut would reduce real benefits to around $1,200 a month, or roughly to where they are today. Yes, the do-nothing, doom-and-gloom scenario envisions initial Social Security benefits basically staying flat over the next two decades. This is what passes for a "crisis" these days.

But this raises a question. If pension coverage is higher now than it was in the 1970s, if 401(k)s and IRAs didn't exist until three decades ago, and if Social Security benefits used to be lower, how did Americans used to retire?

The truth is, many of them didn't. They worked until they died.

The whole theory of retirement for all is a relatively new idea. You can see here, before World War II, the majority of American males age 65 and up were still active in the labor force. Previous generations of Americans worked into their 70s and beyond at levels we couldn't fathom today. The labor force participation rate for males over age 65 would have to fully double from where it is today -- meaning retirement in that cohort would have to fall by half -- before we return levels that prevailed in the 1960s and 1970s. Oddly, that's a nostalgic time some consider "the glory days" of American retirement.

We have to differentiate between things not getting better as fast as they used to and things getting worse. They are easy to conflate, but two very different things. For Boomers, the gap between "this isn't ideal" and "your living standards will be worse off than your parents" is pretty deep.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.